"Banking Sector Turmoil: How Government-Brokered Purchases are Creating a Vicious Cycle"

 

The recent government-brokered purchases of troubled banks, including First Republic, Signature, and Silicon Valley banks, have created a vicious cycle in the US banking sector. According to industry sources, troubled lenders now need to fail and receive government assistance before potential buyers will step up.

This cycle was highlighted by the recent acquisition of First Republic Bank by JPMorgan Chase & Co after it struggled to find a private-sector buyer. The FDIC seized the bank and struck a deal with JPMorgan to take control of most of its assets. JPMorgan paid $10.6 billion to the FDIC and locked in a loss-sharing agreement with the government on residential mortgages and commercial loans. The FDIC also provided JPMorgan with $50 billion of financing for five years at an undisclosed fixed rate as part of the deal.

However, this phenomenon is raising concerns that the current turmoil will accelerate the concentration of the banking sector in the US around a handful of institutions. This could reduce competition for consumers and deepen the risk if a giant bank fails.

The acquisition of Silicon Valley Bank, which collapsed in March and sparked the ongoing turmoil in regional banks, was also purchased by First Citizens BancShares with FDIC help. This purchase drained about $20 billion from an insurance fund that is financed by banks and run by the government.

Similarly, the acquisition of the collapsed Signature Bank by New York Community Bancorp also involved a buyer cherry-picking parts it wanted to take and leaving unwanted assets, such as Signature's crypto portfolio. The deal cost the fund $2.5 billion.

After these transactions, publicly-traded buyers are now motivated to wait for ailing lenders to collapse so they can get better terms from the FDIC. This is because it is cheaper, the stock price goes down, and there are fewer natural problems in M&A negotiations that may not end in a deal.

According to financial risk consultant Mayra Rodríguez Valladares of MRV Associates, "After what happened with First Republic, banks don't want to buy any other bank before the FDIC takes over."

FDIC officials, however, say would-be buyers risk losing out if they allow the value of an acquisition target to deteriorate over time while waiting for an FDIC receivership. The FDIC must follow the "least-cost" test when accepting a winning bid in a receivership process, ensuring that the regulator accepts the offer that creates the lowest drag on the Deposit Insurance Fund.

Although US bank mergers were already sluggish due to rising interest rates and the looming recession, the current market volatility is making it even more difficult to strike deals. This was exemplified by the shares of Los Angeles-based PacWest Bancorp, which jumped 82% on Friday after sinking more than 40% on Thursday over news the company was exploring options to bolster its finances.

Furthermore, while US authorities were able to offset the requirements of traditional acquisitions in the three receivership processes, they have set an expectation that they will continue to extend sweeteners to buyers to offset potential losses on undesirable parts of shuttered banks' portfolios.

In allowing JPMorgan, the largest US bank, to purchase a collapsed lender, officials have upended a long-held view that the government would block banking giants from getting bigger. This has raised concerns that bank rescues are unintentionally favoring bigger banks, at a time when depositors are pulling their money out of smaller banks and seeking safety in larger institutions.

Since the global financial crisis in 2008, the banks deemed too big to fail due to their importance to the global economy have only gotten bigger. For example, JPMorgan's assets ballooned to $3.7 trillion at the end of the first quarter, up from nearly $1.6 trillion at the end of 2007.

Another benefit of buying through FDIC receiverships is that it allows buyers to acquire troubled banks at a discount, giving them the opportunity to turn a profit. The FDIC provides financing and loss-sharing agreements that can help buyers take on the risks associated with acquiring a struggling bank.

In addition, the FDIC receivership process is designed to protect depositors and prevent bank failures from causing systemic risks to the broader financial system. By intervening and facilitating the sale of troubled banks, the FDIC is able to mitigate the negative impact of bank failures on the economy and ensure that depositors are not left without access to their funds.

However, the current trend of buyers waiting for banks to fail before stepping in to acquire them could lead to an even more concentrated banking sector in the US. This could limit competition and increase the risk of systemic failure if a large bank were to collapse.

To prevent this, regulators may need to consider implementing policies that encourage more active M&A activity in the banking sector, or find ways to incentivize buyers to acquire troubled banks before they fail. In the meantime, the FDIC will continue to play a critical role in managing the fallout from bank failures and facilitating the sale of troubled banks to buyers who can help to stabilize the industry.